Central bank takes “data dependent” approach to interest rate hikes

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Bank of Canada Governor Stephen Poloz said on Thursday the bank will move cautiously on interest rate hikes as it takes a data dependent approach to monitoring several economic issues.

"When the central bank makes interest rate decisions, it does so with a focus on where inflation will be in the future. Any change in interest rates will not have its full impact on inflation for about a year and a half to two years," the central bank chief said during a speech at St. John’s in Newfoundland and Labrador.

Although inflation forecasts start with economic models, Poloz clarified that the central bank still applies real-world judgment before reaching a policy decision. "A lot of this judgment comes from conversations with people."

"Equally important are efforts to gauge business sentiment—sometimes called ‘soft data’—and to gather intelligence about the real economy from business leaders," he added. "We need to understand the view from both Main Street and Bay Street to help inform our outlook for growth and inflation."

By data dependence, Poloz meant that the central bank pays close attention to all the information it receives, including data, sentiment indicators, and intelligence. It then makes continuous inferences about not just how the economy is evolving, but how behaviours may be changing.

Among the myriad of economic issues the institution is monitoring, Poloz gave four: economic capacity, inflation and technology, wage growth, and elevated household debt.

"In such an environment, we simply cannot rely mechanically on economic models. This does not mean we are abandoning our models. It does mean we need to use them with plenty of judgment, informed by data, sentiment indicators and intelligence, as we go through the delicate process of bringing inflation sustainably to target," Poloz said.

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